If interest rate parity does not hold,
A)covered interest arbitrage opportunities will exist.
B)covered interest arbitrage opportunities will not exist.
C)arbitragers will be able to make risk-free profits.
D)covered interest arbitrage opportunities will exist, and arbitragers will be able to make risk-free profits.

Question

Quizplus · Accepted Answer

Interest rate parity ensures that the return on investments in different currencies is equal once hedged with a forward contract. If it does not hold, arbitrageurs can exploit the difference in interest rates across countries, after accounting for the forward exchange rate, to make risk-free profits. This is known as covered interest arbitrage.

If Interest Rate Parity Does Not Hold